banking exchange rates and forex business

8/10/2019 Banking Exchange Rates and Forex Business

1/34

CAIIB Super-Notes M S Ahluwalia Sirf Business

Exchange Rates and Forex Business

Module A: International Banking
http://sirfbusiness.blogspot.com/search/label/CAIIBhttp://sirfbusiness.blogspot.com/search/label/CAIIBhttp://sirfbusiness.blogspot.com/search/label/CAIIBhttp://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/http://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/search/label/CAIIB


2/34


CAIIB SUPER NOTES

Bank Financial Management: Exchange Rates and Forex Business
http://sirfbusiness.blogspot.com/search/label/CAIIBhttp://sirfbusiness.blogspot.com/search/label/CAIIBhttp://sirfbusiness.blogspot.com/search/label/CAIIBhttp://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/http://sirfbusiness.blogspot.com/http://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/search/label/CAIIB


3/34


Contents

Coverage:

1. Foreign Exchange Definition

and Markets

2. Factors Determining

Exchange Rates

3. Exchange Rate Mechanism

4. Foreign Exchange DealingRoom Operations

5. RBI/FEDAI Guidelines


4/34


FOREIGN EXCHANGE DEFINITION AND MARKETS

1.


5/34


Foreign Exchange- Definition

Conversion of currencies from the currency of invoice to the home

currency of the exporters generally required for cross border

trade

A For Ex Transaction is a contract to exchange funds in one

currency for funds in another currency at an agreed rate and

arranged basis.

All claims payable abroad, whether consisting funds held in foreign

currency with banks abroad or bills, checks payable abroad.

(*Defined under FEMA foreign exchange management act, 1999 Section 2)


6/34


For Ex - FEMA Definition

Foreign Exchange means foreign currency and includes:

i) All deposits, credits and balances payable in foreign currency, and

any drafts, travelers cheques, letters of credit and bills of exchange,

expressed or drawn in Indian currency and payable in any foreign

currency,

ii) Any instrument payable at the option of the drawee or holder

thereof or any other party thereto, either in Indian currency or in

foreign currency, or partly in one and partly in other.


7/34


ForEx Market Participants

Central Banks

Commercial Banks

Investment funds/banks ForEx brokers

Corporations

Individuals

- Managing their reserves and using currency markets to smoothen out the value of their home currency

- Offeri ng exchange of curriencies to their retail clients a nd hedging and investing their own assets andliabilities, as also on behalf of their clients, and also speculating on the movements in the markets

- Movin g funds from one country to another usi ng excha nge markets as a vehicle for investments as also he dging th eirinvestments in various countries / currencies

- Acting as middleman, between other participants, and at times taking positions on their boo k

Moving funds between different countries and c urrencie s for investment or trade transactions oreven speculation in currency markets.

Ordinary or high net worth individuals using markets for their investment, trade, personal and travel & tourism needs.
http://sirfbusiness.blogspot.com/search/label/CAIIBhttp://sirfbusiness.blogspot.com/search/label/CAIIBhttp://sirfbusiness.blogspot.com/search/label/CAIIBhttp://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/http://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/search/label/CAIIBhttp://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/search/label/CAIIBhttp://sirfbusiness.blogspot.com/http://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/search/label/CAIIBhttp://sirfbusiness.blogspot.com/http://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/search/label/CAIIB


8/34


Foreign Exchange Markets

Characteristics:

24 hour market

an over the counter market

a global market with no barriers/no specific location

supports large capital and trade flows

highly liquid markets

high fluctuations in currency rates settlements affected by time zone factor

markets affected by governmental policies and controls


9/34


FACTORS DETERMINING EXCHANGE RATES

2.

Th t ti i th FE k t d d th d li t f th f i i h f t f th t i b i h d
http://sirfbusiness.blogspot.com/search/label/CAIIBhttp://sirfbusiness.blogspot.com/search/label/CAIIBhttp://sirfbusiness.blogspot.com/search/label/CAIIBhttp://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/http://sirfbusiness.blogspot.com/http://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/search/label/CAIIBhttp://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/search/label/CAIIBhttp://sirfbusiness.blogspot.com/


10/34


Factors Determining Exchange Rates

FundamentalReasons

FundamentalReasons

Balance of PaymentBalance of Payment

Economic Growth RateEconomic Growth Rate

Fiscal PolicyFiscal Policy

Monetary PolicyMonetary Policy

Interest RatesInterest Rates

Political IssuesPolitical Issues

TechnicalReasonsTechnicalReasons

Freedom or Restrictionof Capital Movementdue to Govt. Controls

Freedom or Restrictionof Capital Movementdue to Govt. Controls

Movement to highyielding currenciesMovement to highyielding currencies

SpeculationSpeculation

Provides depth andliquidity to the marketand acts as a cushion

Provides depth andliquidity to the marketand acts as a cushion

The qu otation in the FE markets depend on the delivery type of the foreign currency, i. e. excahnge of strea ms of th e two currencies being exchanged.The spot rates, being the base quotes in the forex markets are more dynamic and are effected by varied reasons. They are as under:

These in clude all those causes or events, whichaffect th e basic economic & monetary policies of he conc erned govt. Affects the long term exchange

rates, no effect in the short run

General ly a surplus leads to a raise in imports

while a deficit weakens a currency

A high g rowth - increase in imports & vice

versa

An expan sionary policy, eg: lower taxes can lead

to a higher economic growth

How the central banks attenpts to influence

& control interest and money supply can impactthe value of currency of their country

High do mestic interest rates tend to attract overseascapital, h enceshort ter m gain. however high interest rates slowsdown the economy, thus weakening the currency.

Political s tability = Economic Stability = Steady

currency & vice versa

can affec t exchange rates to a larger extent.

Capital t ends to move from lower yieldingcurrencie s, and results, is movementin exchange rates.
http://sirfbusiness.blogspot.com/search/label/CAIIBhttp://sirfbusiness.blogspot.com/search/label/CAIIBhttp://sirfbusiness.blogspot.com/search/label/CAIIBhttp://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/http://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/search/label/CAIIBhttp://sirfbusiness.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/http://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/search/label/CAIIB


11/34


EXCHANGE RATE MECHANISM

3.


12/34


Types of Transactions

Settlement of funds on the same day (t+0)Ready/CashReady/Cash

Settlement of funds on the next working day (t+1)TomTom Settlement of funds on the second working day

(t+2)SpotSpot

Delivery of funds on any day after the spot date

ForwardForward Date on which exchange of currencies actually takes placeValue date


13/34


Forward Margins Premium and Discounts

Forward Rate = Spot Rate + Premium (or - Discount) Premium: Forward Value of Currency > Spot Value

Discount: Spot Value of Currency > Forward Value

In a perfect market, with no restriction on Finance and Trade, the

interest factor is the basic factor in arriving at the forward rate

Forward price of a currency can be worked out on the basis of: Spot price of the currencies involved The interest rate differentials for the currencies

The term, i.e., the future period for which the price is worked out


14/34


Type of Quotes

Foreign currency expressed in terms of homecurrency (Local Currency is Variable)

Also called Home Currency or Price Quotations Ex: USD 1 = Rs. 44.35

Direct QuoteDirect Quote

Home currency expressed in terms of foreigncurrency

Ex: Rs. 100 = USD 2.25.Indirect QuoteIndirect Quote

Inter bank quotesTwo-way QuotesTwo-way Quotes

Internationally, all currencies other than GBP, Euro, AUD and NZD are quoted as direct rates.


15/34


Cross Rates

When rates for a particular currency pair are not directly

available

Ex: USD/INR Rate is 49.10/11

GBP/USD Rate is 1.5000/10

GBP/INR Rate will be: 49.10 x 1.5000/49.11 x 1.5010


16/34


Fixed vs. Floating Rates

Fixed Rate: Official rate set by the monetary authorities for

one or more currencies

Floating Rate: Value of the currency decided by supply anddemand factors

The floating rate system is prevalent in the world market since

1973. India adopted the same in 1993.


17/34


Bid and Offered Rates

Bid rate: Buying Rate

Offered Rate: Selling Rate


18/34


Terminology

1 Per Mille: 1 part in every thousand

Valuer Compensee payments: Where value date is same in

both centers Arbitrage:

Simple/Direct Arbitrage: Between 2 centers only

Compound/Three (or more) Point Arbitrage: Where additional centersare involved


19/34


FOREIGN EXCHANGE DEALING ROOM OPERATIONS

4.


20/34


Functions

1. To meet requirements of customers of other

branches/divisions to buy or sell foreign currency.

2. Manage Foreign currency assets and liabilities.3. Fund and manage Nostro accounts

4. Undertake proprietary trading in currencies.


21/34


3 Parts of a Dealing Room

F r o n t O

f f i c e

F r o n t O

f f i c eDealing Room

Dealers who areactually involved in

buying and selling thecurrencies, orundertaking marketactivities.

Dealing Room

Dealers who areactually involved in

buying and selling thecurrencies, orundertaking marketactivities. M

i d O

f f i c e

M i d O

f f i c eRisk Management,

and parametrizationof Risks for forexdealing operations.

Compliance ofguidelines andinstructions.

MIS

Risk Management,and parametrizationof Risks for forexdealing operations.

Compliance ofguidelines andinstructions.

MIS B a c

k O

f f i c e

B a c

k O

f f i c eFollow up and

Processing/Settlementof deals, Accounts,Reconciliation etc.

Follow up andProcessing/Settlementof deals, Accounts,Reconciliation etc.


22/34


Positions

Reflects inflow and outflow of funds i.e. receivables andpayables.

Mismatches between the two throw open interest rate Risks. Comprises of items that are both ready(immediate effect) andforward in nature

Funds PositionFunds Position

Deals with overbought or oversold positions. The overall net position exposes the dealer to exchange Risks

from market movements.

Currency PositionCurrency Position


23/34


Terminology

ExchangePosition/Position The difference between

the amount of a currencybought and the amount ofthe same currency sold isknown as position inthat currency.

ExchangePosition/Position The difference between

the amount of a currencybought and the amount ofthe same currency sold isknown as position inthat currency.

Overbought Position If the amount of FC boughtby a bank is more than theamount sold, thedifference between thetwo isOverbought/Long/Plus

position

Overbought Position If the amount of FC boughtby a bank is more than theamount sold, thedifference between thetwo isOverbought/Long/Plus

position

Oversold Position If the amount of FC sold bya bank is more than theamount bought, thedifference between thetwo isOversold/Short/Minus

position.

Oversold Position If the amount of FC sold bya bank is more than theamount bought, thedifference between thetwo isOversold/Short/Minus

position.

Square Position If the amount of FC bought

by a bank equals theamount sold, then thebank is said to havesquare position. If thereis a small difference, it isknown as Near Squareposition

Square Position If the amount of FC bought

by a bank equals theamount sold, then thebank is said to havesquare position. If thereis a small difference, it isknown as Near Squareposition

Open Position Exchange position at given

point of time

Open Position Exchange position at given

point of time

O/N Position Open Exchange position at

the end of the day

O/N Position Open Exchange position at

the end of the day


24/34


Major Risks associated with ForEx Dealing Operations

OperationalRisk

OperationalRisk Exchange RiskExchange Risk Credit RiskCredit Risk

Pre-settlement

Risk

Pre-settlement

Risk

SettlementRisk

SettlementRisk Liquidity RiskLiquidity Risk

GapRisk/interest

rate Risk

GapRisk/interest

rate RiskMarket RiskMarket Risk

Legal RiskLegal Risk Systemic RiskSystemic Risk Country RiskCountry Risk Sovereign RiskSovereign Risk


25/34


RBI/FEDAI GUIDELINES

5.


26/34


Categorisation of Authorised Persons

Cat 1

Authorised DealerBanks

FinancialInstitutions

Other entitiespermitted tohandle all types ofForEx transactions

Earlier known asAuthorised Dealers

Cat 2

Money Changersauthorised toundertake

sale/purchase of FCnotes, travellerscheques, handle FCtransactionsrelating toremittancefacilities.

Earlier known asFull Fledged MoneyChangers (FFMCs)

Cat 3

Allowed toundertake onlypurchase of FC

notes andtravellers cheques

Earlier known asRestricted MoneyChangers (RMCs)


27/34


FEDAI Guidelines/Rules

1. Standard transit period for export bills

2. Crystallisation of bills in foreign currency in case of delay in realisation

within 60 days

3. Sight bills for Import LC would crystallise on 10 th day after date of receipt

4. Forward contracts to have definite amounts and specific delivery dates

5. Delivery period under option contract shall not exceed one month

6. All forward contracts to be automatically cancelled on the 7th

workingday after maturity if not picked up

7. All cancellation at Banks opposite TT rates


28/34


FEDAI Guidelines/Rules

8. Interest @ 2% above the prime rate of the currency to be charged in

event of delay in payment of interbank foreign currency funds

9. Interest @ 2% above the NSE MIBOR to be charged in event of delay in

payment of rupee settlement funds10. All currencies to be quoted as:

Per unit of Foreign currency =INR. Ex: $1 = Rs 45.67

Except JPY, Indonesian Rupaih and Kenyan Schilling. To be quoted as 100 units of

Foreign currency = INR.

FEDAI also prescribes code of conduct for FOREX dealers, as also guidelines withregard to dealings with forex brokers.


29/34


RBI Guidelines

Guidelines related to:

Open positions

Gaps

Borrowing and Lending in Foreign currencies

Interbank dealings in India and overseas markets

Hedging of banks own exposures as well as that of its resident and

non-resident clients


30/34


RBI Guidelines

1. AD CAT 1 Banks allowed to open/close rupee accounts

1. In names of overseas branches or correspondents without prior reference to RBI

2. In names of exchange houses with prior reference to RBI

2. AD CAT 1 Banks allowed to open/close foreign currency accounts abroad

3. AD CAT 1 Banks can undertake investments in overseas markets in money

market instruments and/or debt instruments, issued by foreign state,

maturity < 1 yr, rated as per guidelines

4. Surplus funds in Nostro accounts can be used for

1. Granting Loans to resident constituents

2. Extending credit facilities to Wholly Owned Subsidiaries/JVs of Indian companies

abroad


31/34


RBI Guidelines

5. All borrowings in Nostro accounts (including ECB and Temp. Overdraft) not

adjusted within 5 days shall not exceed 50% of their unimpaired Tier 1 Capital

or USD 10 million whichever is higher

6. Banks can allow banks to book Forward Exchange contracts to hedge their

exchange risk exposure

- The genuineness of the underlying documentary evidence and exposure must be

ascertained

7. Banks can allow importers/exporters to book Fwd. Contract on basis of

declaration of the exposure with limit based on past performance

8. SME customers may be allowed to book forward contracts in alignment with

the credit facilities availed by it from the bank


32/34


RBI Guidelines

9. Banks can allow resident individuals to book Forward contracts on

deliverable basis with tenors up to 1 year up to a limit of USD $ 100,000.

10. Banks can offer other derivative contracts to resident entities who have

borrowed foreign exchange in accordance with the provisions of FEMA1999

11. Banks can also offer Foreign currency Rupee Swap to resident entities

that have a forex or rupee liability to hedge long term exposure

12. Banks can enter into cross currency options and foreign currency-rupee

options with their customers on back to back basis


33/34


Do you have any questions or queries or some feedback to give?

Just mark an email to [email protected]
http://sirfbusiness.blogspot.com/search/label/CAIIBhttp://sirfbusiness.blogspot.com/search/label/CAIIBhttp://sirfbusiness.blogspot.com/search/label/CAIIBhttp://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/mailto:[email protected]:[email protected]://sirfbusiness.blogspot.com/http://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/search/label/CAIIB


34/34

CAIIB Super Notes M S Ahluwalia Sirf BusinessF S N Cli k H

M S Ahluwalia, amongst other things, is a visua

blog designer and of course an MBA and BankDelhi, India.

To know more about him you may visit his blog-site:Estudiante De La Vida
http://sirfbusiness.blogspot.com/http://sirfbusiness.blogspot.com/http://sirfbusiness.blogspot.com/http://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/http://sirfbusiness.blogspot.com/http://msahluwalia.blogspot.com/http://www.facebook.com/pages/M-S-Ahluwalia/258015240783http://twitter.com/msahluwaliahttp://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/http://sirfbusiness.blogspot.com/http://sirfbusiness.blogspot.com/http://sirfbusiness.blogspot.com/http://sirfbusiness.blogspot.com/http://sirfbusiness.blogspot.com/http://msahluwalia.blogspot.com/http://sirfbusiness.blogspot.com/search/label/CAIIB

banking exchange rates and forex business

Documents